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Does anchoring impede investors’ interpretation of earnings news?

by Dr Yuan Li, Research Associate, Cambridge Centre for Finance and Cambridge Endowment for Research in Finance

Anchoring impedes investors’ interpretation of earnings news

Yuan Li
Dr Yuan Li

In his best-selling book, Thinking, Fast and Slow, Nobel Memorial Prize in Economics laureate Daniel Kahneman describes anchoring as “one of the most reliable and robust results of experimental psychology”. Using data from the real financial markets, CCFin research associate Yuan Li and her research collaborators Thomas George and Chuan-Yang Hwang find evidence suggesting that anchoring impedes investors’ interpretation of earnings news.

Anchoring is the tendency for individuals to base their forecasts of an unknown quantity upon a salient statistic (the anchor) that might have nothing to do with the quantity being forecasted. The classic example is an experiment in which individuals observe the generation of a random number, after which they are asked to estimate the percentage of African nations in the UN as an increment to the random number. The estimates are higher (lower) for individuals who observe higher (lower) random numbers. This random number is the anchor in this experiment.

In the real financial markets, investors anchor on the 52-week high price (52WH), which is often featured in financial websites and papers. If the stock price prior to a positive (negative) earnings announcement is already close to (far from) the 52WH, investors would think the positive (negative) news has already been incorporated into the price, and hence be reluctant to bid the price higher (lower). In other words, investors behave as if future price levels are constrained not to deviate too far from the 52WH.